How proprietary trading works and why it is regulated
Most brokers earn by executing trades for clients. Some also trade with their own money. This is called proprietary trading, or prop trading. This page explains how proprietary trading works, why it is watched closely and what rules apply in India.
Quick answer
Proprietary trading, often called prop trading, is when a bank, broker or trading firm trades shares, derivatives or other assets using its own money, to earn profit for itself rather than for clients. Because a firm's own trades can conflict with client interests, regulators require clear separation, disclosure and risk controls. In India, brokers must tell clients whether they do proprietary trading.
Key takeaways
- Proprietary trading uses the firm's own money, not clients' money.
- Profits and losses belong to the firm.
- It can create conflicts of interest with clients.
- Indian brokers must disclose to clients if they trade on their own account.
- Many prop firms use algorithms and high-speed systems.
What is proprietary trading?
In normal broking, the firm places orders for clients and earns brokerage. In proprietary trading, the firm itself is the trader. It takes positions in shares, futures, options, currencies or bonds, hoping to earn from price moves or price gaps.
Prop trading desks may use strategies like arbitrage, market making or short-term trading. Many modern prop firms rely heavily on algorithmic and high-frequency trading systems.
Why are conflicts of interest a concern?
A broker sees client orders before they reach the market. If it also trades for itself, it could be tempted to trade ahead of large client orders. This is called front running, and it is illegal.
The firm might also favour its own trades when markets are busy. To prevent this, rules require proprietary and client activity to be kept separate and clearly identified.
Rules for proprietary trading in India
| Rule area | What it means |
|---|---|
| Disclosure | Brokers must tell clients if they do prop trading |
| Order tagging | Prop and client orders are marked separately on exchanges |
| Separate accounts | Firm money and client money must be kept apart |
| Risk limits | Exchanges and SEBI set position and margin limits |
SEBI requires stock brokers to disclose to their clients whether they trade on their own account. Exchanges also tag orders as proprietary or client orders, so regulators can track both. Using client funds or securities for the firm's own trades is not allowed.
How big is prop trading in Indian derivatives?
SEBI's study of the equity F&O segment, released in September 2024, found that in FY24, proprietary traders made gross trading profits of about Rs 33,000 crore before costs, and that most of these profits came from trading through algorithms. Over FY22 to FY24, about 93 percent of individual traders in the segment made losses.
These figures are a reminder that individual traders often compete against well-funded firms with fast technology and deep research. Past results are not indicative of future results.
Prop trading abroad and 'prop firms'
In the US, the Volcker Rule, part of the 2010 Dodd-Frank Act, limited proprietary trading by large banks that take deposits. Some online 'prop firms' now offer funded trading accounts after a paid test. Their terms vary, and anyone considering them should read the rules carefully and check whether they are regulated.
In short, proprietary trading is a firm trading for itself. Rules on disclosure and separation are there to protect clients and keep markets fair.
Frequently Asked Questions
What is proprietary trading?
Proprietary trading is when a firm trades with its own money for its own profit, rather than executing trades for clients.
Is proprietary trading allowed in India?
Yes, subject to SEBI and exchange rules. Brokers must disclose to clients if they do proprietary trading and keep client and firm activity separate.
What is the conflict of interest in prop trading?
A broker that trades for itself might trade ahead of client orders or favour its own trades, which is why separation and disclosure rules exist.
How much did prop traders earn in Indian F&O?
SEBI's September 2024 study found proprietary traders made gross trading profits of about Rs 33,000 crore in FY24, before costs.
What is the Volcker Rule?
The Volcker Rule is a US rule from the 2010 Dodd-Frank Act that limits proprietary trading by large deposit-taking banks.
Disclaimer: Investments in the securities market are subject to market risks. Please read all related documents carefully before investing. This article is intended for informational and knowledge purposes only and should not be considered tax, financial, or investment advice. Tax laws and deductions may vary based on individual circumstances and regulatory changes. Readers are advised to consult a qualified tax advisor or financial professional before making any investment or tax planning decisions.
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